The results that Apple (AAPL) announced Tuesday night after the close of trading weren’t terrible–they essentially matched the Wall Street consensus. I wouldn’t say that about the company’s forecast for the quarter that ends in March. Revenue will show the first quarterly drop sine 2003.
That’s clearly an Apple problem. In the holiday quarter just ended iPhone shipments fell short of projections and Wall Street has moved beyond worry that Apple has hit a limit to global sales of high end smartphones.
The question that trading tomorrow, Wednesday January 27, will go a good way to answer is does Apple’s problem constitute a problem for technology stocks as a whole or maybe even for the U.S. market in total? After all, this isn’t a market that’s swimming in revenue and earnings growth.
On a one quarter basis the results just released weren’t especially dire. The company generated a record $18.4 billion in net income on sales of $75.9 billion for the period. Earnings per share came to $3.28 versus a Wall Street estimate of $3.23 a share. None too shabby given that Apple calculates that a strong U.S. dollar took a 15% bite out of sales. Gross margin was essentially intact at 40%.
But the results reinforced investor fears that iPhone sales have plateaued and the Apple is too dependent on just this one product.In the quarter iPad sales dropped to 16.1 million units, against projections of 17.3 million and Mac computer sales were 5.31 million against estimates of 5.8 million units.
I think Apple will eventually be ok–but I think investors are looking at another rocky quarter ahead–at the least. A sustained recovery will require either the launch of a strong new product or two that will reduce Apple’s dependence on the iPhone for growth or growth in the company’s service business to a size where it can pull more weight in the company’s top line. Revenue from the company’s services business which includes its streaming music unit, its app store and Apple Pay grew to $31 billion in 2015. But that’s just not enough at a company where total revenue for just the most recent quarter quarterly revenue totaled $76 billion.
Tomorrow I think we’ll get to see how much clout Apple has in the wider stock market. I’d expect these numbers will take down shares of companies in Apple’s supplier network. Look to shares of Skyworks Solutions (SWKS), Cirrus Logic (CRUS), and Qualcomm (QCOM) as indicators. (You should be aware that some analysts on Wall Street are looking for shares in Skyworks and Cirrus Logic to move up now that Apple has “capitulated” and all the bad news, in their opinion, is out.)
Qualcomm is a bridge stock to the wider technology sector since Apple is by no means the company’s only customer. To see how the Apple results are playing in the wider technology sector check some of the momentum technology stocks such as Netflix (NFLX) and Palo Alto Networks (PANW.) These companies don’t have any business exposure to Apple but if fears of a growth slowdown hit the market, they are likely to show up first in these high risk momentum shares.
And finally check in on the NASDAQ Composite. That index has been flirting with bear market territory and if Apple gives a pessimistic edge to technology in general, I’d expect it to show up in this index.
Let me be honest.
When I recommended selling Qualcomm (QCOM) out of my Jubak’s Picks portfolio on April 2, I wasn’t imagining anything like yesterday’s earnings debacle.
The stock closed at $67.97 on April 2 and I recommended taking profits because valuation looked stressed considering the number of competitors that were putting pressure on margins in Qualcomm’s smartphone chip business. The stock jumped to obey my sell by climbing slightly for the next month or two until it hit $69.86 on June 3. Shares then crept gradually lower until yesterday’s earnings report sent them down to $61.78, a drop of 3.75%.
It’s actually amazing to me that the stock didn’t fall further. For the quarter ended June 30, Qualcomm reported earnings of $1.2 billion, down from $2.2 billion in the year-earlier quarter. Revenue fell 14%. Chip shipments were flat year over year.
And then Qualcomm said things would be worse next quarter, the fourth quarter of Qualcomm’s fiscal year. For the quarter that ends in September Qualcomm projected earnings of 51 cents to 76 cents a share on revenue of $4.7 billion to $5.7 billion. The Wall Street consensus had seen the company earning 95 cents a share on sales of $6.13 billion.
Qualcomm’s quarter and its projections for next quarter highlight a problem across the technology sector. Very few technology companies are making very much money. And those that are can expect to see everybody including my Aunt Tilly chasing them. Qualcomm had averaged better than 20% annual sales growth since 2010 because of its dominance of the market for high-end chips that connect phones to the fastest data networks using the LTE standard. But that dominance has been under attack from companies such as Taiwan’s MediaTek, Korea’s Samsung, Arm Holdings (ARMH), and Intel (INTC). In fact in the first three months of the year Samsung and MediaTek grabbed 19% of the market. The loss of a huge order from Samsung’s smartphone business to Samsung’s chip unit was a major contributor to the end of a 19-quarter string of year over year sales growth at Qualcomm.
I don’t see the dynamic that turned this quarter into such a disappointment for Qualcomm turning around quickly. Qualcomm is predicting rather modest compounded annual growth of mid- to high-single digits in the 3G and 4G-device market over the next five years with average selling price (ASP) of the chips that go into those phones staying flat. That seems optimistic to me given that competition has been driving ASPs lower over the last couple of years, but the view is pessimistic enough to explain why so much of Qualcomm’s reaction to this quarter has focused on cost cutting–$600 million in fiscal 2016 and then an additional $1.1 billion in annual reductions.
The other part of Qualcomm’s response to the challenge of this quarter is to announce that it will be looking to address new markets with management citing networking, mobile computing, Internet of Things, and automotive as adding up to a $10 billion addressable opportunity now with growth to $20 billion by 2020.
I think you can readily see the problem with targeting those opportunities. Lots of competitors are going after the same markets—Cisco and Google (GOOG) in the Internet of Things, for example. Intel is willing to pour billions and then more billions into mobile computing. Apple and Google have both targeted the automotive opportunity.
That doesn’t mean it’s not worth going after these opportunities, but it is important to think about those opportunities in the context of the current pattern in the technology sector of one or two companies dominating a market and collecting all the profits from that market. Qualcomm cited in its conference call the growing concentration in its own sector. That’s a development that should be familiar to technology investors from the examples of Microsoft (MSFT), Intel, and Cisco Systems (CSCO). According to Qualcomm just two companies—Apple (AAPL) and Samsung account of 85% of the premium smart phone segment. The two companies account for an even bigger percentage of the profits in the smartphone sector: Apple accounts for 92% of profits in the smartphone sector, according to Canaccord Genuity, with Samsung pulling in 15%. The rest of the sector shows a loss—which is how Apple and Samsung can add up to more than 100%.
Looking at these numbers and trends I have to wonder if Qualcomm wouldn’t do a better job for shareholders if it eschewed the short-term solutions being urged on it by activist shareholders and instead concentrated on building an unassailable position in 5G technologies based on its clear lead in 4G technologies. That would produce some short-term pain, undoubtedly, since 5G technology is emerging only slowly. (From a long-term perspective it’s the lag in 5G adoption that accounts for much of Qualcomm’s current disappointment.)
And looking at the Qualcomm story I have to wonder if the pattern of concentrating all the profits in a sector in just a few companies doesn’t go a long way to explaining the number of young technology companies that are concentrating on growing revenue and market share as fast as they can—with the hope that someday that will result in the kind of market dominance that has made Apple such an amazingly profitable company.
Of course, it is a whole lot easier in the current technology market to build a strategy around growing revenue as fast as possible and letting profits take care of themselves somewhere down the road. At least that way a CEO doesn’t flag a profit opportunity and attract lots of competitors.
Update: February 11, 2015. It was all about royalties going into ARM Holdings’ (ARMH) February 11 report on fourth quarter earnings. The worry holding the stock down for much of 2014 had been an apparent decline in royalty growth from companies that licensed ARM’s chips to 7% in the fourth quarter of 2013, then to 4% in the first quarter of 2014, and 2% in the second quarter.
Royalty growth had picked up in the third quarter of 2014—to 11% year over year—and the company had guided to mid-teens growth in the fourth quarter. That looked like a recovery but would the company be able to deliver?
For at least the fourth quarter, the answer is Yes. Royalty growth from the company’s licensing of its chip technology climbed to 16% year over year. (In U.S. dollar terms licensing revenue grew 30% year over year.) Net profit, consequently rose to $111 million from a loss in the forth quarter of 2013.
For the rest of 2015 the company said it expects continued momentum in licensing revenue on the strength of growth in smartphone (especially iPhone 6) sales and on the introduction of new smartphones this year incorporating ARM’s 8-A architecture.
Shares of ARM Holdings fell for much of 2014 on the fear that growth in royalty revenue had slowed permanently, but it now looks like stock bottomed at $39.28 on October 22. As of the close today, February 11, at $50.31 shares have gained 28%. On the technical charts, ARM finally showed the 50-day moving average crossing back above the 200-day moving average in late January. That pattern is usually an indication of a continued upward trend.
The company’s product pipeline also points to continued strength. It’s new Cortex A-72 Maya processor has been licensed to a dozen companies including MediaTek. The design, ARM says, is 3.5 times faster than the ARM processors used in most smartphones sold last year and uses 75% less energy. The company’s new Mali-T880 graphics processor for mobile devices also looks to play into the heated competition among smartphone makers to add bigger displays with more graphics while increasing the speed to the user.
ARM Holdings has been a member of my Jubak’s Picks portfolio http://jubakam.com/portfolios/ since October 25, 2013. My gain during that period has been an un-awe-inspiring 5.31%. But I think ARM is moving into a product and royalty cycle sweet spot. As of February 11 I’m raising my target price for June to $60 a share from the prior target of $56.
I‘m going to sell Apple (AAPL) out of my Jubak’s Picks portfolio http://jubakam.com/portfolios/ today, February 24. The stock has hit my target rice of $132 that I set for March.
And I’m starting to see the kind of hype that I think marks a seasonal high for Apple.
Specifically, I’ve started to see Apple Watch fever.
In the headlines. On February 17, for example, a Reuters story reported a Wall Street Journal story that Apple (AAPL) had asked its Asian suppliers to make 5 to 6 million units of three Apple Watch products for an April launch. Taiwan’s Quanta Computer, the sole assembler of the Apple Watch, would operate 24-hours a day during the Lunar New Year holiday at Quanta’s factory in Changzhou, China to make an entry level Apple Watch Sport model (50% of production), a mid-level Apple Watch (33% of production) and a high-end Apple Watch with a 18-karat gold case.
And in the share price. Apple shares are up 18% from January 27 to the close on February 23 at $133. That puts the share price above the old 52-week and all-time high of $128.88 and near the $135.07 that marks the top of the stock’s Bollinger Band.
Back when Apple reported its December quarter earnings on January 27 the 52-week high was $119.75 and I set a target price of $132 for March. I noted that the December quarter was always the company’s biggest and that it would take runaway excitement about the Apple Watch to send the shares up from their post-December quarter bounce.
Well, we’re seeing that excitement. We’ve got a new high. The shares are at the top of their range. Ask yourself if you think there are a lot of potential Apple buyers out there who don’t already own the stock.
And this is still a seasonal stock that typically falls off as revenue and earnings decline from their December highs into the spring and summer.
So I’m selling in order to take advantage of that seasonality (and the possibility that the Apple Watch will be a success but still fail to live up to expectations)—with the idea of rebuying in July or August
Apple’s shares are up 74% since I added them to this portfolio on May 18, 2012.
On March 26 http://jubakam.com/2015/03/i-see-signs-of-a-month-of-weakness-in-u-s-equities-ahead-on-growth-worries/ I expressed my worries about falling earnings in the first quarter—with earnings for the Standard & Poor’s 500 companies forecast by Wall Street analysts to decline by 4.8%–and suggested that it was time to raise some cash to hedge against a market retreat and to use in buying bargains if earnings season, due to start next week, created any.
With yesterday’s forecast for 0% GDP growth for the first quarter from the Atlanta Fed http://jubakam.com/2015/04/12750/ I think the danger of a drop on first quarter earnings and growth worries has increased.
And I think it’s time to act on my worries and raise a little cash in my Jubak’s Picks portfolio. I’m not selling today—selling ahead of a 3-day weekend is a good way to get a low price—but on Monday I will be selling shares of Qualcomm (QCOM) out of that portfolio. The shares are up 47.56% as of April 2 since I added them to the portfolio on July 15, 2009.
Why sell Qualcomm in particular right now? (Or on Monday anyway.)
The company’s sales are very leveraged to China and growth in China is falling. Qualcomm announced recently that it had lost a big customer. That is thought to have been Korea’s Samsung. The technology sector has shown relative weakness recently. Qualcomm’s chart shows a troubling pattern of lower highs in 2015. And a bushel of pretty good competitors are all gunning for Qualcomm’s market right now—Intel, Arm Holdings, and MediaTek to name three.
I don’t expect this to be the last sale out of the portfolio in coming days.